Exchange Rate Regimes and Financial Dollarization: Does Flexibility Reduce Bank Currency Mismatches?

Abstract

The dollarization of bank deposits and credit is widespread in developing countries,resulting in varying degrees of currency mismatches in domestic financial intermediation, which in turn may accentuate balance sheet problems and thus financial fragility. It is widely argued that flexible exchange rate regimes encourage banks to match dollar-denominated liabilities with a corresponding amount of dollar-denominated assets, ameliorating currency mismatches. Does the behavior of dollar deposits and credit in financially dollarized economies support that presumption? A new database on deposit and credit dollarization in developing and transition countries is assembled and used to address this question. Empirical results suggest that, if anything, floating regimes seem to exacerbate, rather than ameliorate, currency mismatches in domestic financial intermediation, as those regimes seem to encourage deposit dollarization more strongly than they encourage matching via credit dollarization.